Microsoft’s (MSFT) fantastic fiscal first-quarter results and stellar guidance on Tuesday demonstrated once again that the software giant is one of the most formidable contenders in the increasingly competitive AI arms race.

• Revenue for the three months ended Sept. 30 increased about 13% year-over-year, to $56.52 billion, beating analysts’ forecasts of $54.5 billion, according to estimates from LSEG.

• Adjusted earnings-per-share (EPS) increased 27% from last year, to $2.99, ahead of analysts’ estimates for $2.65 a share, LSEG data showed.

SUMMARY

A clean quarter and better-than-expected guidance should push the stock even higher Wednesday. The quarterly performance was driven by revenue beats across the board, highlighted by a surprise acceleration in revenue at cloud-computing platform Azure and a return to growth at the personal-computing unit.

Generating revenue is one thing but maintaining profitability in the face of heavy investing is another. That’s why we were so impressed to see that Microsoft’s investment in artificial intelligence did not hold back margins. This was the company’s biggest earnings beat since July 2021. And Microsoft pulled this off doing a terrific job balancing its long-term commitment to investing in AI with driving leverage in the business. A case in point was its exceptional operating-margin expansion, up roughly five points from last year.

While guidance was generally higher, the company is still in the early innings of making money off its AI tools and services, as evidenced by the slower turnaround at Azure.

Next week, Microsoft will begin monetizing 365 Copilot, an everyday AI assistant that it argues will make users of applications like Excel, PowerPoint and Teams more creative and productive. Roughly 40% of Fortune 100 companies are already using Copilot as part of an early-access program, and the feedback could not be better.

“Customers tell us that once they use Copilot, they can’t imagine work without it,” CEO Satya Nadella said Tuesday.

Microsoft’s leadership in AI has become abundantly clearer with each passing quarter, keeping us bullish about its future.

RESULTS

When reviewing this near-clean sweep of beats, what stood out most was Microsoft’s intelligent cloud segment, which saw revenues increase by almost 20% from last year, to $24.26 billion. That figure handily beat analysts’ estimates of $23.49 billion and the company’s guidance range of $23.3 billion to $23.6 billion. Within this segment, Azure and other cloud services revenue grew 29% year-over-year, topping estimates of 26.2%. But what was even more impressive was the sequential uptick in growth from the 26% annual growth rate seen in the fiscal fourth quarter, ending Azure’s five-straight quarters of decelerating revenue growth.

One reason why Azure trends accelerated in the quarter was the benefit of AI services, which contributed roughly three points of growth. AI adoption continued for Azure, with Microsoft saying it now has more than 18,000 organizations using Azure’s services, which are based on OpenAI technology. That’s up from the more than 11,000 organizations in the prior quarter.

Nadella touted Azure’s AI leadership on the post-earnings conference call, calling its AI infrastructure the best for both training and inference, while noting it has deployed its AI services in more regions than any other cloud providers. This could be one reason why Microsoft claims Azure took share in the quarter. 

Another notable part of the quarter was Microsoft’s personal-computing segment, which finally returned to revenue growth after a stretch of weakness in the PC market. Revenues at the division increased about 2.5% from last year, compared with an expected decline of 3.5%. What helped flip the quarter was the return to growth in Windows OEM, up 4%, and strong demand for M365, which drove a pickup in Windows commercial products and cloud-services revenue. Gaming was also a strong, with Xbox content and services revenue increasing 12% on a constant-currency basis.

Rounding out the quarter, revenue at the productivity-and-business-processes unit increased about 13%, to $18.59 billion, beating estimates of $18.19 billion. Some key highlights include the 17%-constant-currency increase in Microsoft Office commercial revenue growth, which benefitted from a 10% increase in seat growth. The 10% figure is a downtick from the 11% growth rate in the fiscal fourth quarter, but it’s still growing steadily.

This tells us that widespread corporate layoffs haven’t materially impacted Office 365 seats, which essentially represent the number of business users accessing the digital software. Microsoft also saw an increase in consumer subscribers to Microsoft 365, which ended the quarter at 76.7 million, up from 74.9 million in the fourth quarter.

GUIDANCE

Management’s outlook was better than expected, allowing the stock to hold on to its initial gains in afterhours trading. In total, Microsoft expects revenues to increase about 14.5% to 16.4% year-over-year in its fiscal second quarter, well above estimates of about 11% growth. However, it is unclear if the consensus fully reflects the impact of the recently completed acquisition of Activision Blizzard, which comes under the personal-computing division.

Second quarter Azure revenue growth is expected to be 26% to 27% in constant currency. On the one hand, that’s well above the 24.4% growth rate predicted by analysts, according to FactSet. However, it would also represent a deceleration from the 28% growth rate registered last quarter. Investors who had hoped for a return to accelerating growth thanks to AI may have been disappointed to hear Microsoft say revenue growth in constant currency should remain stable from the second quarter through the second half of the year, despite a higher contribution from AI.

Meanwhile, Microsoft expects second-quarter operating expenses to be $15.5 billion to $15.6 billion, which is a little higher than the $15.3 billion estimated by analysts. Additionally, full-year operating margins are expected to remain flat year-over-year, as the company balances investments in the cloud and AI with maintaining its focus on operating leverage.